Amid a seemingly resilient U.S. economy, Denver-based Janus Henderson Investors sees signs of a potentially more fragile environment than many in financial markets believe.
Perhaps the strongest signal that the U.S. economy is facing headwinds can be found in the makeup of the 10-year Treasury yield BX:TMUBMUSD10Y, which includes a “meteoric” rise in the inflation-adjusted, or real, yield. According to Adam Hetts, portfolio manager and global head of multi-asset investing at Janus Henderson, that real return is about 2.5% and represents the highest cost of capital that U.S. companies and households have faced in over a decade.
Real yields reflect the stated yield of long-term government bonds after accounting for inflation. Higher real yields are good for savers and generally drive more investors into cash-like vehicles, while riskier options like stocks become less attractive. They are a key factor in the recent rise in the nominal 10-year yield, which broke 5 percent in October and was around 4.6 percent on Tuesday.
“Importantly, nominal yields have continued to rise even as inflation has eased,” Hetts wrote in a commentary distributed Tuesday and posted on his firm’s website. “We interpret this as a recognition of a possible regime change in tariffs.”
Janus Henderson, who manages $308.3 billion in assets, isn’t the only big name to suggest that the U.S. economy may be more fragile than it seems. In late October, Pershing Square’s Bill Ackman said that “the economy is slowing faster than recent data suggests,” and Bill Gross, co-founder of fixed-income investment giant Pacific Investment Management Co., said he expects the economy to slow over the course of the year There will be a recession this year. End.
In Janus Henderson’s case, the firm recommends investors prioritize “quality companies that are capable of stable cash flow and have solid financials as we enter the later stages” of the current cycle.
Here are more reasons Hetts sees hopes for a soft landing for the U.S. economy fading and what investors can do about it.
Personal savings are decreasing
“The surge in personal savings due to pandemic-era stimulus packages is largely over,” Hetts said. “In addition, consumption has recently been controlled via credit cards. Given that borrowing costs have returned to their highest levels in more than a decade, we question the desire – or ability – of American households to continue making such purchases.”
In many places prices are higher in the long term
Another reason to doubt the sustainability of consumption is “our long-held view that key interest rates will remain elevated for longer,” with expectations for a central bank turnaround in 2024 “tempered,” Hetts wrote.
“This risk is exacerbated by our belief that the U.S. economy – and others – has not yet felt the full force of previous interest rate hikes,” he said. “Compared to other tightening cycles, we are still at a relatively early stage, meaning that the demand restraint sought by the restrictive policy is still being felt in the system.”
Reasons to stay defensive
Unlike fixed income, which has repeatedly been subject to aggressive sell-offs, low-quality corporate bonds must reflect the myriad risks that come with higher interest rates.
The spread between high-yield corporate bonds and those of risk-free benchmarks “remains below the long-term average,” Hetts wrote. “Our concerns for this segment are compounded by the risk of an unexpected hard landing, which could strain the leveraged business models of some of these companies.”
Stock returns, decomposed
The risks of higher interest rates and a potentially harder-than-expected economic “landing” are not spread evenly across stocks, with mega-cap technology and internet companies faring better than the broader market.
“Many of these business models, in our view, are well positioned to weather an economic downturn because they offer consistent cash flow generation, strong balance sheets and exposure to enduring long-term themes,” Hetts said. “Value stocks and stocks that are more cyclically exposed could, however, come under additional pressure in a slowing economy.”
Diversify
Uncertainty about how long interest rates will remain high, coupled with geopolitical risks, is clouding the outlook and causing market volatility. This volatility and uncertainty causes asset classes such as stocks and bonds to occasionally move in parallel.
But bonds “have the potential to act as such.” [a] Ballast on riskier assets in a broad portfolio,” said Hetts.
On the one hand, yields have reached a level that offers attractive return potential and potentially lower volatility if interest rates remain within the current range. On the other hand, if a rapidly weakening economy forces central banks to turn around, which is not in line with Janus Henderson’s base case, “the capital appreciation potential of bonds could offset losses in more cyclically exposed asset classes.”
In short, bonds are relatively more attractive and offer the potential for income and “capital generation” in a risk aversion scenario.
In afternoon trading in New York on Tuesday, all three major stock indexes DJIA SPX COMP were higher as bond investors sent 3- BX:TMUBMUSD03Y to 30-year Treasury yields BX:TMUBMUSD30Y in search of stabilization
down.